President Obama, in an attempt to recoup some of the money being spent to revive the economy, proposes to repeal several tax provisions near and dear to the oil and gas industry:
- Enhanced oil recovery credit
- Marginal well tax credit
- Expensing of intangible drilling costs
- Deduction for tertiary injectants
- Passive loss exception for working interest owners in oil and gas properties
- Manufacturing tax deduction for oil and gas companies
- Percentage depletion deduction for oil and gas
- Not surprisingly, the oil and gas industry is mounting a huge lobbying campaign to prevent loss of these tax benefits.
The only one of these tax benefits that directly affects royalty owners is the percentage depletion deduction. Currently, 15% of royalty income is deductible as “percentage depletion.” The deduction is intended to recognize that the sale of oil and gas is in part the sale of a depleting asset, so that a portion of the royalty should be treated like a return of capital rather than as income.
The principal argument being made against repeal of these tax benefits that are peculiar to the oil and gas industry is that their repeal would reduce the amount of oil and gas produced in the U.S., because those who invest in exploration and production would be less willing to do so, or would invest less. The argument would be difficult to defend if oil were above $100 per barrel and gas were above $12 per mcf, as they were last summer.
The oil and gas industry has always been subject to price volatility. When prices are low, the industry obtains tax breaks by using the argument that the breaks are necessary to avoid declines in domestic production. When prices are high, the same tax breaks provide a windfall to the industry.
It will be interesting to see if the Administration’s plan can withstand the onslaught of opposition from the industry and royalty owners.